EUR 850.00 For Business Accounts Only

Morningstar | DXC Margins Continue Upward; Digital Services Provision Remains a Focus; Shares at a Discount

DXC reported reasonable third-quarter results with the firm delivering sequential growth in revenue, bookings, operating income, and EPS. The company remains a patchwork of messy moving parts and is our only no-moat IT services provider. We see a high degree of risk with the firm as it rebuilds after spinning off from Computer Sciences Corporation, or CSC, continues to integrate HPE’s Enterprise Services business, removes its U.S. Public Sector, or USPS, business, and now looks to integrate its recent $2 billion acquisition of Luxoft. While CEO Mike Lawrie has a lot of work to do in order to consolidate, streamline, and grow the business, we give him credit for past turnaround success with CSC. To that end, we are encouraged by the firm’s ongoing ability to improve its adjusted EBIT margins and believe the underlying quality of the firm’s work is improving in areas surrounding digital transformation services. The company is still hampered by legacy exposure to heavy integration workloads, which will persist in the near term, but the management team is working diligently to rotate to higher value, in-demand services. To that end, we think recent acquisitions of Luxoft and EG A/S illustrate DXC’s willingness to make sweeping maneuvers to improve their digital services stance. Our view of DXC remains unchanged after the quarter and we retain our $91 fair value estimate and no-moat rating for this company. Shares had been trading at a significant 5-star discount at the end of 2018, but with shares rising approximately 25% in the last month and 5% afterhours, they now trade in 4-star territory and we’d only recommend the company to investors with a high appetite for risk.

For the quarter, revenue declined 5.2% year over year to $5.18 billion (fell 2.6% in constant currency). In constant currency, global business services revenue dipped 4.0% to $2.17 billion and global infrastructure services revenue decreased 1.5% to $3.01 billion. The dynamics across the two segments were in line with prior quarters and continue to reflect headwinds in application services and legacy infrastructure services. Positively, the company did have a good sequential bookings result of $5.7 billion in the quarter and recorded strong growth in digital revenue with a book-to-bill of 2.1:1. Nevertheless, we don’t expect any notable near-term acceleration in revenue growth as the firm still has significant exposure to low growth IT services, which will take multiple years to pare back.

DXC’s adjusted EBIT margin improved 160 basis points year over year to 16.2% and reflects actions surrounding automation, labor improvements, supply chain efficiency, and footprint rationalization. While we think the firm may struggle to generate meaningful revenue growth for some time, we believe the margin expansion story remains far more achievable and expect continued focus on these cost saving levers.